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Expert Advice

Apr. 2, 2009

Discovering Foreign Tax Returns

By Craig A. Roeb
Federal and state tax returns generally are privileged, but what about foreign tax returns?

By Craig A. RoebIn litigation, the defense may request documentation from the plaintiff to support claimed damages. If the plaintiff has filed tax returns outside the United States - an increasingly common phenomenon in the global economy - the most credible, accurate, and reliable evidence of the plaintiff?s income (or lack thereof) may be aforeign-filed tax
return. Are such tax returns discoverable?

Though California courts have recognized a
statutory privilege against the disclosure of state and federal income tax
returns (Webb
v. Standard Oil Co., 49 Cal. 2d 509 (1957)),
they have also recognized that the privilege is not absolute (Schnabel, 5
Cal. 4th at 721).

No authority exists to shield disclosure of tax
returns filed in a foreign country. Although the policy barring involuntary
disclosure of state and federal returns is designed to encourage the voluntary
filing of those returns, along with the truthful reporting of income to
facilitate tax collection (see Schnabel, 5 Cal. 4th at 719), no such
policy extends to foreign-filed tax returns.

The reason for the difference is that the federal
and state governments do not have an interest in promoting the policies of
foreign governments. This hands-off attitude explains why the California
Legislature has not (and arguably cannot) pass laws that affect the affairs of
other nations, as such action would encroach on exclusive federal control over
foreign affairs. (See League
of United Latin Am. Citizens v. Wilson, 908 F.
Supp. 755 (C.D. Cal 1995).)

In an instructive California case involving a
dispute over a loan and promissory note, the defendant asked the plaintiff to
produce his Canadian tax returns. The defense was grounded in the notion that
the note had been extinguished, that payment on the note had been arranged
through various tax shelters, and that the plaintiff supposedly wrote off the
note as uncollectible in his Canadian-filed income tax return (Firestone
v. Hoffman, 140 Cal. App. 4th 1408, 1411 (2006)).
Prior to trial, the plaintiff filed a
motion in limine seeking to exclude
evidence relating to his tax returns,
especially the Canadian tax return.
The defendant opposed the motion, arguing that the Canadian tax return could
provide circumstantial evidence that the note had been written off. The trial
court granted the plaintiff's motion and excluded any reference to his Canadian
tax return.

But the court of appeal reversed, recognizing
under Webb that a statutory privilege against disclosure extended only
to state and federal tax returns. A Canadian tax return was another story:
?[T]here is no legal authority for application of the privilege to foreign tax
returns. As a matter of policy, California has no interest in devising means to
ensure effective tax enforcement in Canada - that is exclusively the prerogative
of the Canadian government. - (Firestone, 140 Cal. App. 4th at 1420.)

Federal courts also have dealt with this problem.
In a dispute between two parties over a joint venture and percentage of ownership, the defendant requested that the
plaintiff produce his state, federal, and foreign tax returns. The court was
sensitive to the public policy against unnecessary disclosure of tax returns,
and it required a showing that the material was not otherwise discoverable
before ordering production of any tax documentation. However, the court also
stated: ?[T]ax returns are discoverable where they are relevant to the action
or the issues raised thereunder and the material is not otherwise readily
available.? (Potluri
v. Yalamanchili, 2007 WL 2571980 (E.D. Mich.
Sept. 4, 2007.) Ultimately, the court ordered the plaintiff to
produce his federal, state, and foreign-filed tax returns.

We?ve come a long way since the 1957 Webb
decision. The world has gotten smaller, claims have become larger, and in the
21st century, evidence may well be spread over continents instead of counties.
Today, whenever a globe-trotting individual asserts claims of lost income, or a
multinational company is involved in a business dispute, information that could
be dispositive on issues of liability or damages may reside in a foreign-filed
tax return. Discovering that information is a strategy for any savvy
litigator to consider.

Craig A. Roeb is a partner in
the Los Angeles office of Chapman, Glucksman, Dean, Roeb & Barger, where he
chairs the business, employment, and product liability practice groups.